Economies of scope are "efficiencies formed by variety, not volume" (the latter concept is "economies of scale").
In economics, "economies" is synonymous with cost savings and "scope"
is synonymous with broadening production/services through diversified
products. For example, a gas station that sells gasoline can sell soda,
milk, baked goods, etc. through their customer service representatives
and thus gasoline companies achieve economies of scope.
Economics
The term and the concept's development are attributed to economists John C. Panzar and Robert D. Willig (1977, 1981).
Whereas economies of scale for a firm involve reductions in the average cost
(cost per unit) arising from increasing the scale of production for a
single product type, economies of scope involve lowering average cost by
producing more types of products.
Economies of scope make product diversification, as part of the Ansoff Matrix, efficient if they are based on the common and recurrent use of proprietary know-how or on an indivisible physical asset.
For example, as the number of products promoted is increased, more
people can be reached per unit of money spent. At some point, however,
additional advertising expenditure on new products may become less effective (an example of diseconomies of scope). Related examples include distribution of different types of products, product bundling, product lining, and family branding.
Unlike economies of scale, "which can be reasonably be expected
to plateau into an efficient state that will then deliver high-margin
revenues for a period", economies of scope may never reach that plateau
at all. As Venkatesh Rao of Ribbonfarm explains it, "You may never get
to a point where you can claim you have right-sized and right-shaped the
business, but you have to keep trying. In fact, managing the ongoing
scope-learning process is the essential activity in business strategy.
If you ever think you’ve right-sized/right-shaped for the steady state,
that’s when you are most vulnerable to attacks."
Natural monopolies
While in the single-output case, economies of scale are a sufficient condition for the verification of a natural monopoly,
in the multi-output case, they are not sufficient. Economies of scope
are, however, a necessary condition. As a matter of simplification, it
is generally accepted that markets may have monopoly features if both
economies of scale and economies of scope apply, as well as sunk costs or other barriers to entry.
Advantages
Economies of scope have the following advantages for businesses:
- Extreme flexibility in product design and product mix
- Rapid responses to changes in market demand, product design and mix, output rates, and equipment scheduling
- Greater control, accuracy, and repeatability of processes
- Reduced costs from less waste and lower training and changeover costs
- More predictability (e.g., maintenance costs)
- Faster throughput thanks to better machine use, less in-process inventory, or fewer stoppages for missing or broken parts. (Higher speeds are now made possible and economically feasible by the sensory and control capabilities of the “smart” machines and the information management abilities of computer-aided manufacturing (CAM) software.)
- Distributed processing capability made possible and economical by the encoding of process information in easily replicable software
- Less risk: A company that sells many product lines, sells in many countries, or both will benefit from reduced risk (e.g., if a product line falls out of fashion or if one country has an economic slowdown, the company will likely be able to continue trading)
However, not all economists agree on the importance of economies of scope; some argue that the concept applies only to certain industries, and then only rarely.
Examples
Economies of scope arise when businesses share centralized functions (such as finance or marketing) or when they form interrelationships at other points in the business process (e.g., cross-selling one product alongside another, using the outputs of one business as the inputs of another).
Economies of scope served as the impetus behind the formation of large international conglomerates in the 1970s and 1980s, such as BTR and Hanson in the UK and ITT in the United States.
These companies sought to apply their financial skills across a more
diverse range of industries through economies of scope. In the 1990s,
several conglomerates that "relied on cross-selling,
thus reaping economies of scope by using the same people and systems to
market many different products"—i.e., "selling the financial products
of the one by using the sales teams of the other"—which was the logic
behind the 1998 merger of Travelers Group and Citicorp.
3D printing is one area that would be able to take advantage of economies of scope, as it is an example of same equipment producing "multiple products more cheaply in combination than separately".
If a sales team sells several products, it can often do so more
efficiently than if it is selling only one product because the cost of
travel would be distributed over a greater revenue base, thus improving
cost efficiency. There can also be synergies
between products such that offering a range of products gives the
consumer a more desirable product offering than would a single product.
Economies of scope can also operate through distribution
efficiencies—i.e. it can be more efficient to ship to any given location
a range of products than a single type of product.
Further economies of scope occur when there are cost savings
arising from byproducts in the production process, such as when the
benefits of heating from energy production has a positive effect on agricultural yields.
